Monday, July 14, 2008

A Falling Knife?

An old friend and former stock broker with Merrill Lynch wrote the following:

A Falling Knife?
I am starting to wonder if WB is the 2008 version of NEB. The market is telling us WB has severe problems.

My friend and I suffered though the tough market of 1990. At the start of the market decline, in 1989, the Bank of New England was compared to Wachovia, the solid conservative bank of the north. Pundits predicted a fast turn around but what they got, on January 7, 1991, was bankruptcy.

"This time is different." This time, hardly anyone expects a quick turn around. The prevailing theory is that there will be a domino list of bank failures. The TV pundits who are the least bit optimistic are optimistic for next year. I don't blame my friend for making the comparison of WB today to NEB back then but I think he has forgotten what happened after the bankruptcy. Over the next few days, the S&P went down from about 320 to about 310 but within a month it was up to 370. Less than a year later it hit 420. Oil that traded at $48 per barrel in 1990 traded for $23 in 1991. The S&P went up 31% in one year following the bankruptcy but most energy, basic materials and staple stocks did not do well. Many a portfolio saw cash on cash returns of 50 to 100%. Margin accounts saw gains of several hundred percent. Go back through history and you will find that bank failures have occurred right at the bottom. The Indy Bank has scared a lot of folk but this "crisis" need not spread to WB.

The signs of the turn continue to pile up. Lumber prices have recovered from extreme lows, showing us that the worst of the housing crunch is over. Bank assets will recover sharply as soon as the congress and the Bush administration stop talking about what needs to be done. The firm that advertises less talk, more action has the right idea. I believe WB is a strong buy, but, to be honest, I thought so before the last 50% decline. It is extremely difficult to buy at ever lower prices but logic says that the lower the prices go, the deeper one should dig to buy, buy, buy. In a similar situation in 1963, two neighbors had an extra $5,000. The one bought a car and the other bought stock. In 5 years, the one owned a 5 year old car and the other owned $1.5 million dollars worth of stock. Big gains are made by buying stocks when they are cheap.